CFO Bridge Insights December 2023

Charting the Course: Cash flow Metrics

Cash flow metrics of Top 10 Indian IT companies and inference

The data of the Top 10 Indian IT players is gathered from their Annual reports of FY’23. We are studying the cashflow generation in relation to Net Income and the dividend payout as % of Operating cash flow (OCF).

On review of the above table what is observed is as follows:

• Cash generated from operating cash flow activities (OCF) expressed as a % of PAT or Net Income (NI) indicates how much OCF out of NI is generated in cash. Ideally the expectation is 1:1 or 100% or closer to the same. In the above tabulation barring 2 companies the rest are generating higher OCF/NI ratio. Infosys is marginally lower and LTIM is significantly down in FY23.

• Next, we are assessing the dividend pay out which is part of the financing activities and expressed as % of OCF. This indicated out of the OCF how much the company retains to plough back into business and how much is given back to shareholders. There is no right answer here, if there are no investment opportunities then companies share the profit with the shareholders. In such cases out flow will be high and cases where the same is lower, one needs to see if the same is rightly invested to generate more growth opportunities or any repayment of borrowing etc. Barring the top 3 and Tech M, the rest of the companies’ payout is 50% or below. Infosys also had another outflow Rs. 11,499 crores towards buy-back payout as well plus buyback related spend too which is also deemed as payout to shareholders.

With this background let’s try to understand it further from the Tech SME standpoint.

Need for cashflow management in Tech SME and how to approach?

We observe that in many Tech SME companies the process of preparing the cash flow statement as part of the normal monthly MIS pack takes a low priority or is non-existent. We through this newsletter urge all concerned to ask finance teams to report cashflow statements and balance sheets of your business as part of the monthly reporting pack. At business leadership level please do a review of the same with your finance team to gather actionable insights to improve your cash flow management. Needless to mention, a better cash managed company has a better valuation, and a review of the financials will speak for itself.

The finance team would prepare the P&L statement, Balance sheet and Cashflow statement as per the prescribed Companies Act format and as leaders we need to know how to read and interpret the same, so our focus now would be to understand this part better.

Now let’s understand at a very high level what are the components of a Cash flow statement:

A cash flow statement is prepared for a period to show the movement in cash balance between start of a period and end of the period bifurcating the walk into three categories – Operating, Investing and Financing activities.

Operating Activities(A): This bucket will show the cash flow generated from the normal business operations and referred to as OCF. For better understanding this is represented as Cash profit adjusted for changes in net working capital and net tax outflow.

Investing Activities(B): This bucket will represent the investment in assets/business or sale thereof, buying and selling of securities, deposit and maturity of bank deposits and interest income majorly. Typically, these are relating to investing activities by the companies.

Financing activities (C): This bucket will represent the cash flows pertaining to payment of dividend, payment of interest or finance costs, payment of lease liabilities, borrowing and repayment, buy-back payment, and related expenses outflow.

Sum total of A+B+C represents the net cash flow generated which explains the net change in cash balance. So, if the above is negative then there is cash outflow and if it is positive there is cash inflow. The key point to note is whether operating cash flow is positive or not.

Points to focus on for improving cash flow or how to manage a crisis:

• Work on making the business profitable as per benchmarks, you may refer to our earlier newsletters on how to focus on P&L improving levers.

• We spoke in an earlier article on DSO (Debtors Sales Outstanding) wherein we shared how to do better Accounts Receivables management. Do ensure you do not block your cash in the form of accounts receivables. Please give the due attention to this since most of the companies get stuck or slip into a debt trap because of poor attention.

• A loss or low margin company, low attention on receivables management goes as a combo and a clear symptom of a crisis waiting to happen. It will be a vicious cycle, first the vendor payments will get delayed, Bank overdraft limits will get exhausted, salary payment will get delayed, statutory payments will get delayed. Had the company conserved cash it would tide over the situation. It is like a situation where the hole in the sailing boat has happened, and you may need to take a call on what to survive until receiving SOS support.

o   The crisis management is very important since the spend would have to be classified as Vital, Essential and Desirable. All desirable spends have to be curtailed or stopped immediately to conserve cash. Essentials have to be relooked and optimally spent linear to revenue. Vital spend will also need to continue but after review.

o   Companies renegotiate the terms with their Vendors to get extra credit terms, long term this impacts the procurement rates.

o   Sale of receivables – companies can do factoring of good receivables since not all companies could negotiate without recourse model. But this comes at a cost. Sometimes clients also have a supplier financing model where at a charge they will pay the receivables within 7 days.

o   Instead of buying an asset with upfront payment explore rent or short-term leases after a proper ROI

•  At times, companies at this point would try to bring in new investors to invest and this would result in dilution of their shareholding. The new investor would invest only if the story of investment makes sense, and it would give the desired valuation and ROI in a few years.

• Some end up taking unsecured borrowings through known sources but that will become a debt trap since it comes at exorbitant cost and debt servicing becomes even more challenging if repayment cannot happen in a short time. Take care of the financing and Investing activities as below: Do not invest in non-income generating assets which can block your cash by not being liquid when needed.

o   Park your surplus cash under proper guidance and ensure you generate Interest or other income and be careful not to lose you capital. Be prudent in your investment decisions.

o   Plan your acquisition, dividend outflow , buy back judiciously.

o   Hope you follow the above to do better cash flow management.